Small property investment deals often fall in the shadow of large, trophy property sales that come with hefty price tags. But sales activity for real estate priced below $5 million is proving to be just as hot as it is for those larger assets.
Broadly speaking, the total number of real estate transactions across the spectrum is at an all-time high. “The market is absolutely screaming, and that also includes transaction volume for properties below $5 million,” says Hans Nordby, managing director with the portfolio strategy group of research firm CoStar. Total commercial real estate sales in the U.S. spanned 37,598 individual transactions totaling some $210.3 billion during the first half of the year. Deals priced below $5 million accounted for 21.7 percent of that dollar volume at $45.7 billion, and 82 percent of total sales with 30,831 properties trading hands, according to CoStar.
In general, there is great demand for investment property in that under-$5 million price range, and about 95 percent of that activity is coming from private capital, notes Steve Kawulok, managing broker with real estate services firm Sperry Van Ness / Denver Commercial LLC. The smaller value deals are below the radar for most REITs and institutional investors, and instead are dominated by local and regional buyers such as high-net-worth individuals, family trusts, LLCs and business owners.
Similar to the broader market, demand for smaller real estate assets has been on the rise in the past few years as investors searched for alternative investments that generated decent yields. Real estate is also attracting more new capital from high-net worth individuals, as well as owner-occupiers of space looking to buy properties to support their business operations. Sales transactions for properties priced under $5 million hit a record high of $100 million in 2014, and sales for the first half of 2015 are tracking just slightly behind that pace at $45.7 billion, according to CoStar.
“We are finding that the mix of investors includes a lot of first-time investors into the commercial real estate market,” says Kawulok. For example, Kawulok recently sold a $3 million industrial building in suburban Denver to a family in the farming industry. The family had additional income from oil and gas royalties due to fracking occurring on some of their land. They chose to use that money to buy an income-producing property, which was their first investment in commercial real estate.
Another key factor driving sales activity in the sub-$5 million sector is that banks are lending again, and a lot of the small deals are bought by people who use leverage. “I’m hearing more in the past year about small and medium banks, and even credit unions, that are lending now,” says Nordby. “That source of capital was non-existent in 2009. So this is really the grease that makes the transaction volume mill run.”
In addition, there is abundant capital for owner-users to buy their own real estate through SBA financing or conventional financing.
Traditionally, single tenant net lease properties account for a big chunk of the under-$5 million market. There are a lot of bigger institutions and REITs, as well as individuals, who are chasing those net lease deals that are backed by national credit tenants such as Walgreens, Burger King or AutoZone. Beyond that, local investors have a strong appetite for properties across the spectrum, including smaller office, apartment, retail and industrial buildings.
That demand is creating a very competitive market for buyers. Well-positioned properties that have reasonable tenancies are receiving multiple bids, often going under contract within 30 days of hitting the market, notes Kawulok.
The challenge for buyers is the lack of the supply. Supply of small commercial buildings has been next to nothing for the last 10 years, notes Nordby. Starting in 2016, the rents and sale prices will likely be high enough that developers will move forward with more small-building projects. The small banks that lend on this type of small building development have capital and are ready to do construction lending again. “So I think we are going to see a lot more construction next year.”